Part 1 US Expat Tax Preparation and the Foreign Earned Income Exclusion

A key part of US expat tax preparation you need to understand is the Foreign Earned Income Exclusion, which is a series of US expat tax credits for those who are working abroad. These tax credits are reported on Form 2555 which is filed along with your Form 1040 as part of your US expat tax preparation.

A US expat’s total income is subject to the exact same tax rates workers within the United States pay. The difference is that as a US expat you have foreign tax credits and foreign earned income exclusions that you can take advantage of to reduce your US expat taxes with your expat tax preparation.

With the foreign earned income exclusion you are able to exclude up to a maximum of $91,500 of the foreign income you earned and claimed the exclusion as part of your expat tax preparation. In addition you may be able to deduct housing and living costs incurred while you are earning an income abroad as part of your expat tax preparation, if you meet the requirements. The credit has the ability to offset all or a portion of the income you earned abroad, against your US expat tax liability.

Expat Tax Preparation and the Residence Test

For a US Expat to qualify for foreign earned income exclusion you must meet one of the following criteria as part of your expat tax preparation:

1. Work and live fulltime in a foreign country as a resident known as the Bona Fide Resident Test
2. Work outside the US for a minimum of 330 days of any 365 days referred to as the Physical Presence Test

While these statement may seem similar they are very different in how they apply to your US expat taxes during your expat tax preparation. As a US expat you are automatically eligible for the exclusion if you are a resident in a foreign country and work outside of the US for a full calendar year, which runs from Jan 1 to Dec 31.

The second requirement means that if you leave the US for business and do not return to the US for greater than 35 days in a 12 month period you meet the qualification. It has nothing to do with the calendar year. For example, if you leave in March 2009 then if by March 2010 you have not returned to the US for more than 35 days you qualify.

Expat Tax Preparation Deductions

If you meet one or both of the above criteria you are allowed to deduct a maximum of $91,500 in foreign earnings for your US expat taxes. In your expat tax preparation if you are married and you file a joint tax return, you could deduct a maximum of $183,000 from your US expat taxes for the year. This amount is indexed for inflation and will increase annually. You would also qualify for the foreign housing deduction with your expat tax preparation.

The Foreign Earned Income Exclusion is based completely on foreign income when calculating and the income earned. You do not include foreign income from interest, rental income, and dividends, because the IRS classifies this as unearned income. Pension income also does not qualify.

In Part 2 of US expat tax preparation and foreign earned income exclusions we’ll look at common problems US expats face on their taxes.